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The Robeco Global Diversified Carry fund was launched in August 2015 to take advantage of a quantitative investment strategy that searches for yield opportunities in different asset classes. In its first year it has delivered a strong return of 7.35%, resulting in a Sharpe ratio of 1.27. In this question and answer session, portfolio managers Klaas Smits and Shengsheng Zhang from Robeco’s Investment Solutions team explain how the fund works, and outline the reasons behind its success.
We launched the fund for three reasons. Firstly, investors face a global search for yield, as interest rates continue to be at or close to historical lows. With carry, we gain global exposure to high-yielding assets. Secondly, the fund is the next step in expanding the Robeco factor investing range, an academically motivated investment style that Robeco has pioneered over the past two decades. Finally, we have seen a growing demand for strategies that can diversify risks away from the mainstream asset classes of equities and fixed income. We’ve seen healthy demand for the strategy so far, and the annual returns achieved provide us with a strong track record.
Carry is the return on an asset when its ‘price’ does not change. For equities we earn the dividends if the share price remains the same; for bonds we receive the coupons if interest rates do not change; and for currencies we gain the interest rate differences if the exchange rates are unmoved. For example, an investor who is unhappy with the Eurozone short-term interest rate of 0% could open an Australian bank account where he or she would receive 2%. This investor will therefore make 2% more interest on the same amount of deposited money, a differential which we call the ‘carry’. The risk, however, is that the Australian dollar depreciates versus the euro, leading to a loss on the exchange rate when converting the money in the Australian bank account back into euros. In this way, carry serves as a buffer to absorb possible losses due to adverse exchange rate movements. What is unique to our Global Diversified Carry fund is that we exploit carry differences in multiple asset classes and countries, while at the same mitigating the risk of price movements.
We search for carry opportunities in three asset classes: equities, bonds and currencies. For equities this means investing in countries with the highest expected dividends; for bonds we look for the highest yield pick-up; and for currencies we seek out the largest short-term interest rate differences. Using a combination of equity, bond and currency carry applications can deliver great diversification benefits. To reduce reliance on a single country, or putting ‘all our eggs in one basket’, we take more than 40 positions in the portfolio. We only select instruments that are highly liquid, such as equity index futures, interest rate swaps and currency forwards, in order to ensure efficient and cost-effective trading under all market circumstances.
While carry is the return that an investor earns when asset prices stay the same, we know that in practice, prices change continuously. A carry strategy therefore not only profits from the carry earned, but can also profit from any positive price changes. The largest risk for a naïve carry strategy would be that market prices move against you. In the fund we mitigate this risk in several ways. Firstly, and most importantly, we take an equal exposure in long positions (assets with the highest carry) and short positions (lowest carry assets). In this way, the portfolio becomes largely insensitive to the direction of equity and bond markets. Taken together with the diversification over countries and asset classes, this protects the portfolio against falling market prices. As an added measure, in our portfolio construction process we increase exposure to winning positions and reduce exposure to losing positions. This means that in the long run on average, the portfolio profits from price movements.
Most funds in the market are dependent on positive market movements to generate positive returns – in short, the asset value such as a stock price must go up. In contrast, Global Diversified Carry has limited market exposure, and by design is able to generate returns in both positive and negative market environments. This makes that the correlation of the fund with traditional assets such as equities and bonds is close to zero in the long run. As such, the fund can be an additional source of return for traditional portfolios. We advise our clients to have a separate bucket in their portfolio to give room for strategies that can deliver more stable overall portfolio returns. And for those clients that have already embraced the concept of factor investing in equities – and perhaps in corporate bonds as well – Global Diversified Carry offers a natural extension to this, giving access to one of the strongest factors in the multi-asset space.
Carry investing means reaping the rewards of exposure to high-yielding assets. A portfolio manager often has a strong tendency to look at individual market prices on a daily and even an intra-day basis. But this is exactly what carry investing is not about. In the Global Diversified Carry fund we earn a bit of carry day after day. In the short run, asset prices can move against you (or in favor of you), but by adopting our diversified approach we are confident that we can manage this risk well. In the long run the carry factor will dominate the volatility from price movements.
We had an excellent first year with a return of 7.35%, measured from September 2015 until August 2016. In line with our historical simulations, the volatility over this period was 6.01%, resulting in a Sharpe ratio of 1.27. All three asset classes had a positive contribution.